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CA Intermediate · Auditing and Ethics · Audit of Banks

During the audit of Sagar Bank's advances, the auditor finds that a term loan account of Rs 80 lakh has had interest charged but not serviced, and the interest remained overdue for more than 90 days as at the balance sheet date. The bank continues to recognise this interest as income on accrual basis. What is the correct audit response?

The auditor should verify that the account is classified as a non-performing asset because interest has been overdue beyond 90 days, and that interest income on it is recognised only on actual receipt, with previously accrued unrealised interest reversed. Accrual accounting for NPAs violates RBI prudential income recognition norms.

  1. AAccept the treatment because interest accrued legally belongs to the bank
  2. BVerify that the account is classified as NPA under RBI prudential norms and that income on it is not recognised but only on realisation basisCorrect
  3. CRequire the bank to write off the entire loan principal immediately
  4. DIgnore it as income recognition is a matter solely of the credit department

Explanation

Under RBI income recognition norms, interest on non-performing assets is recognised only when actually received. An account with interest overdue for more than 90 days is an NPA, so accrual is wrong. The auditor should check classification and reversal of unrealised interest, not demand a full write-off of principal, which is not required by the norms.

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